The last two quarterly earnings releases of Baidu (BIDU, Financial) were definitely not pleasing for China's dominant search engine investors. By the end of October 2014, Baidu posted mixed 3Q results with revenues of RMB13.52B that missed consensus by RMB30M. Last month history essentially repeated itself; the revenue miss reached RMB70M as revenue increased to RMB14.05B during the 4Q. In comparison to its major competitors on the Chinese market, Baidu is much more successful in mobile monetization. From 3Q to 4Q of 2014, mobile revenue surged from 36% to 42% of total revenue, while Qihoo (QIHU, Financial)’s (Baidu’s largest competitor in China) mobile revenue contribution during the same period slipped from 21% to 19% of the total. Chief Financial Officer Jennifer Li commented in a statement:
"The investments we've made in mobile over the last two years have clearly paid off and set the stage for Baidu to capture an even larger market opportunity."
However, the mobile transition also has one significant drawback that investors are concerned about which is that mobile devices generally have less space for more lucrative forms of advertising and therefore a lower Cost-Per-Click than desktops.
Market position
According to Alexa Internet rankings, Baidu.com is currently the fourth-most popular site on the web globally and the first in China. Even though it is gradually losing its market share in favor of Qihoo’s 360.com and Sohu (SOHU, Financial)’s Sogou.com, it still accounts for more than half of the world’s largest market by the amount of internet users, whereas key players in most of the western world, like Google (GOOG, Financial), Bing and Yahoo! (YHOO, Financial), only account for around 2% of the entire search engine market. A different perspective offers the following diagrams, which captured the changes of global market shares of the largest search engines on desktop and mobile platforms over the past two years.
Data Source: Netmarketshare.com
Looking at the diagrams, it is apparent at first glance that Baidu has gained substantial market share among desktop search engines. Moreover, it was the only desktop search engine that did not lose market share between March 2013 and February 2015. Baidu also has a huge opportunity to improve its market share even further if it expands into new markets. It is no surprise that more than 94% of all Baidu’s visitors come from China, as the website is in Chinese only. A simple translation of its search site alone would help it to quickly penetrate many markets around the world, and especially help to improve its global mobile market share as many rapidly growing low-cost Chinese smartphone brands like Xiaomi have Baidu as a default search engine, even in versions intended for overseas markets.
Diversifying business
It is important to realize that today, Baidu is not just a search engine. Similar to Google, it can become a company growing through acquisitions and technological innovation.
Recently, CEO Robin Li announced that Baidu is developing an autonomous car and plans to introduce it as soon as later this year. Meanwhile, Google has built several self-driving car prototypes and is aiming to have a commercial version on the road within five years. Apple (AAPL) is reportedly also working on an electric vehicle and is pushing to start production by 2020.
Baidu’s new affection towards the auto and transportation industry can be further evidenced by buying a minority stake in the hot forthcoming IPO of Uber, a revolutionary and controversial taxi booking service, or a joint $170-million investment in Uxin, one of China’s largest used car auction service providers.
Besides backing auto and transportation projects, Baidu is very active in other fields, such as travel-booking services or applications for smartphones. In 2011, Baidu strategically purchased a 55% stake in the Chinese-language online travel information and booking portal Qunar.com, and in 2013, the company made the largest deal in the history of Chinese Internet by acquiring Android app market place 91 Wireless for $1.9 billion.
Justifiable valuation
A relatively high actual PE multiple of 36 in the case of Baidu appropriately reflects the growth prospects of the company. Analysts’ estimates suggest that Baidu's earnings growth is likely to be 27.8% for FY15, 43.5% for FY16 and 28.3% for FY17. Over the next 5 fiscal year period, it is expected that Baidu’s earnings will grow at a CAGR of 33%. At the given growth rates, Baidu is currently trading at a FY15 PE of 27.9, FY16 PE of 19.5 and FY17 PE of 15.2. Considering the strong earnings growth, the company's PEG ratio is well within 1, suggesting scope for more upside in the stock.
Bottom line
Even though Baidu missed the last two quarters analysts’ estimates and competition in the domestic search engine market is growing, Baidu still remains a long-term play with a lot of hidden potential ahead. The robust earnings growth is likely to continue and support stock upside. Most of the present internet companies are either well diversified but do not deliver extraordinarily high earnings growth, or offer anticipated strong earnings growth, but are too risky. Baidu provides a good balance between these two groups with a justifiable valuation based on its earnings history, future earnings prospects, synergy effects and new business opportunities.
